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Company Question of The Day: How Does HPQ Pop 50%?

Below I have included our head of Technology’s (Rebecca Runkle) note on Hewlett Packard (HPQ). We went through this on our 830AM morning client call. If you’d like access to this call, please email Jen White Kane at

Rebecca continues to be bearish on HPQ – their blowup last week reinforced most of what she has been saying for the past 6 weeks.

If you are looking for levels to trade HPQ, it will finally be oversold at the $29.37 line – I would cover shorts there, and re-short all strength associated with these Barron’s type calls up to what has turned into to a formidable intermediate term Trend line up at $34.94/share. This stock remains over-owned based on expectations that we see as unreasonably optimistic.

Keith R. McCullough
CEO & Chief Investment Officer
Question of the Day: “How Does HPQ Pop 50%?”

In December, Mark Veverka of Barron’s wrote a cover article on Hewlett Packard entitled “Picture of Health”. In it, he opines on Mark Hurd’s leadership skills, HPQ’s defensive positioning and ability to gain share as well as HPQ’s track record for not lowering earnings (in stark contrast to other tech titans). The stock was at $35.

This weekend, we were treated to “How HP Could Pop 50%”. Now that’s an attention getter if I ever saw one. Despite a miss and downward revisions, Veverka continues to like HPQ “over time” and he remains enamored with “Hurd’s operations acumen and proven ability to deliver strong profit margins in the face of adversity”. He claims his HP thesis remains intact and that it was never about revenues in the first place.

Going into the quarter, my HPQ thesis was largely driven by a belief that while HPQ is an impressive cost-cutting story, revenues do matter and revenue expectations (along with earnings and cash flow forecasts) remained too high. There was a level of investor complacency related to HPQ that I just didn’t and still don’t get. Indeed, HPQ missed revenue targets and built inventory on its books and in the channel. This quarter – revenue headwinds remain and now margins will likely suffer as working capital is “fixed”. While there is no doubt that Mark Hurd is one of the most talented executives in technology and that HPPMA (Hewlett-Packard Post Mark’s Arrival) is a much stronger franchise than before – it is not immune to secular and cyclical challenges.

Longer term, I worry about the printing franchise. During HPQ’s investor call, CFO Cathie Lesjak detailed HPQ’s printing results and both Hurd and Lesjak pointed to a correlation between GDP, unemployment and printing demand. When people aren’t working; they print less. Fair, but that’s not the entire picture.
There are secular forces at work too and anyone who thinks printing will return lockstep with the economy is looking at past correlation models and not the New Printing Reality. What is this New Reality? Just take a step back and think about what’s changed and what’s changing. Younger people, who grew up on computers and never really learned to print, are entering the workforce. Our computer screens are higher resolution and larger than they were – even 2 years ago. Behaviorally, we are adapting and don’t feel the need to print as much as before. Wireless technology has penetrated the print environment and while it feels great to get rid of cables – I have yet to rid myself of that laziness factor. If my printer is in the other room and I am comfy on my couch – I think twice about hitting Alt-F, P. This is especially true as I increasingly worry about the environment and “being green”. Technologies are changing beyond the consumer as well – be it Amazon’s Kindle or electronic bus-stop posters – books and advertising are quickly moving to digital form.

Ironically, HPQ is increasing supplies prices in this environment. Perhaps the end-user really is stupid and/or inelastic. But in this economy, with viable third-party alternatives, HPQ runs the risk of pushing those who are still printing into the arms of others (be it competitors or third-party supplies manufacturers). Regardless, I am less inclined to give HPQ the benefit of the doubt then others. When the economy recovers, I doubt print will recover in similar fashion. If I am right, 50% from here (and a return to early 08 multiples) isn’t a slam dunk anytime soon.

PS - FWIW, Hurd sits on News Corp’s board and Barron’s is owned by News Corp.

Rebecca Runkle
Managing Director
Research Edge LLC

Black Gold: A Call Out on the Gold Oil Ratio

Over the last week, we've been scaling into a long oil and short gold position. Our quantitative models were flashing to us that gold was overbought and oil was oversold. Additionally, we are seeing many consensus indicators that support taking the opposite side of the gold trade, including Fast Money and a full-page advertisement in The Economist promoting gold as a safe haven that should be bought. The overbought nature of gold, and oversold nature of oil, is best characterized in the gold / oil ratio. This ratio measures in US dollar how many barrels of oil can be purchased with one ounce of gold.

As the charts below highlight, this ratio is at or near its all time highs. Historically, a ratio near 25 indicates an entry point to sell gold and buy oil and, conversely, a ratio of below 10 equals an opportunity to sell oil and buy gold. As of the close on Friday (2/20/2009), this ratio was at 25.0 based on light sweet crude trading at $40.03 per barrel and gold trading at 1,002.2 per ounce.

Gold and oil quite often rise in tandem due to inflationary concerns and geo-political risks. The price of oil today, and in fact its trajectory over the last six months, suggests that there is a little on the horizon in terms of major geopolitical risks. To some extent, this is a self fulfilling prophecy since when the price of oil decreases, so obviously does the power of Russia, prominent Middle Eastern nations, and Venezuela. In addition, while gold seems to be flashing inflationary concerns, few other commodities are following suit, which means either gold is early, or wrong, in this signal.

To be fair, the gold oil ratio is only one relative value factor and both oil and gold are also driven by a completely independent set of fundamental factors. That said, we reference George Santanyana's guidance: "Those who cannot learn from history are doomed to repeat its lessons." History is quite specifically telling us that the short oil, long gold trade is likely in its final innings.

Daryl G. Jones
Managing Director

Macro Catalysts: Tuesday-Thursday

Hindsight is always crystal clear. Much like last Thursday, today’s gap up open was again one that should have been sold. I sold my long position in China (CAF), and shorted Korea (EWY) into that strength. Now I am long America (SPY) and net short Asia (IFN, EWY).

Now that the Treasury, Fed and FDIC have made their official “US Banking System” statement, all the market has left to trade on is noise. And from the Slum Dog Short Sellers to the manic media, there is plenty of it.

My proactive risk management plan is moving squarely to the Tuesday-Thursday Macro calendar catalysts where whatever leadership we have left in this country’s Financial System will have an open mike to be You Tubed by both the American public and global markets at large:

1. Obama gets his shot herding cats again in speaking to Congress
2. Bernanke will attempt to calm the Senate re today’s “Banking System Statement”
3. Case/Shiller House Prices will be horrendous (lagging economic indicator)

1. Bernanke gets his shot with the House, explaining today’s “Banking System Statement” again
2. Existing Home Sales for January are released (December’s number was better than expected)
3. Earnings season for US Retailers will continue to be as bad as expected

1. Obama’s 1st Budget is release, and he’ll have another chance to herd cats/calm the country
2. New Home Sales (January) are released
3. Jaime Dimon will attempt to find credibility at JPM’s Investor Day

Importantly, the US Government’s CAP (Capital Assistance Program) will be initiated on Wednesday – so there is plenty for Bernanke to be specific about. This market wants specifics. In addition to this CAP plan, I expect Bernanke to start walking the media’s manic horses to water on what TALF (term auction lending facility) means, how much of that capital that the government has started to put to work, etc…

In between now and Thursday, America’s largest banks will continue to go through Geithner’s proposed “Stress Tests” and, all the while, the groupthink associated with a freaked out US market crowd will find their price marking another capitulation bottom. Provided that the VIX stays tucked under the bearish intermediate Trend line of 52.59, my stress levels will hopefully remain relatively low.

Keith R. McCullough
CEO & Chief Investment Officer

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%

EYE ON THE UK: A New Banking Rescue Act

Over the weekend the UK issued the Banking Act of 2009, which allows the Bank of England, Financial Services Authority (FSA) and the Treasury to step up more quickly to rescue troubled institutions, including provisions to temporarily nationalize or sell-off stricken banks. For investors with monies tied up in injured banks, the Act calls for funds to be rapidly transferred to other banks and depositors may now access their money in a matter of days rather than weeks under previous conditions.

The Act is largely a response to the lethargic response of regulators to the collapse of Northern Rock in 2007, in which depositors made a run on the bank after it emerged that Northern Rock sought government help.

Over the weekend PM Brown met with European leaders from the Group of 20 states in Berlin to discuss the global crisis. He said that "banks must act in the long-term interests of their shareholders and therefore of the economy as a whole, not in the short-term interests of bankers." Brown rejected the Banking industry's bonus culture and signaled that Britain must return to traditional savings and mortgage banks. He voiced that loans must be made on "prudent and careful terms," while equally stressing that domestic growth would come from granting loans to first-time buyers, entrepreneurs, and individuals of middle and modest incomes.

RBS and Lloyds, both part-owned by the taxpayers, have asked the government to insure almost 500 Billion Pounds ($720 Billion) of assets as part of the Treasury's plan to spur lending, noted the Sunday Telegraph. Today RBS said it plans to cut cost by more than 1 Billion Pounds by splitting the bank into two units, including a "core" business and second division holding toxic assets. Additionally, Chancellor of the Exchequer Alistair Darling ordered Northern Rock to expand lending by 14 Billion Pounds.

These measures are the first in a series to be announced this week to revive the U.K. banking industry. RBS reports on Thursday and, alongside JPM’s Investor Day, will be our primary focus in terms of timing a catalyst on marked to market, banking regulation, transparency, etc…

Matthew Hedrick


I have communicated three main concerns about RRGB’s business model in the last year or so. First, I thought the company was continuing to grow too fast. Second, I was concerned about the company’s increased contribution to its national advertising fund as management would never quantify the return being generated from the company’s investment. RRGB’s campaign focused only on brand-building advertising, which is never as effective as promoting products at specific price points. Additionally, the expense associated with a national T.V. advertising campaign does not seem warranted for a 400-unit restaurant company. Third, I was bothered by the company’s capital allocation decision to borrow money to buy back stock. RRGB spent $50 million in FY08 to buy back about 1.5 million shares at an average purchase prices of $33.76 while increasing its debt by nearly $70 million.

RRGB addressed all of my concerns on its earnings call last week. The company lowered its FY09 new unit growth to 13-14 new units, down from its initial guidance of 20 and cut its FY09 capital spending expectations by more than 45% from its FY08 level. Management also stated that it has not yet made any decisions about its development plans for FY10, which highlights that the company recognizes the need to be cautious in this environment (20% company-operated unit growth will no longer yield the necessary returns).

The company also announced its intention to lower its contribution to its National Advertising Fund to 0.25% of restaurant revenue in FY09, down from 1.5% in FY08, which depending on sales could result in a $11 million reduction to FY09 marketing expenses. Specifically, RRGB does not plan to run any national cable advertising. Management justified this decision, saying “In the second half of 2008 while we continued our brand building campaign on national cable TV we began to see a slowdown in incremental traffic so to help form our 2009 plan we tested both pricing and product news on TV in two markets in Q4. Based on this test and the overall results of our advertising in the second half of 2008 we concluded that in this current economic environment it would be more prudent to capitalize on the awareness gains and focus our marketing dollars on more targeted traffic driving and retention initiatives in 2009.” Although I am not sure whether the company’s advertising was ever yielding the necessary returns, I am encouraged to see that the company was evaluating the effectiveness of its marketing spend and decided to lessen its investment at this time. Going forward, the company is going to allocate more of its marketing dollars to its national online advertising and loyalty initiatives.

Regarding share repurchases, RRGB still has a $50 million authorization in place and said that it may make opportunistic purchases of common stock in FY09. The company does not, however, plan to increase its debt to execute these share repurchases. Instead, management stated that it expects to use its free cash flow to pay down outstanding debt during the year.

RRGB, like its competitors, will continue to face margin pressure in 2009 as it expects both same-store sales and traffic to remain negative. Due to the uncertainty around sales, the company decided not to provide either FY09 sales or earnings guidance. That being said, in this environment, it is encouraging to see companies that are working to manage the things they can control and RRGB seems to finally be heading in the right direction on that front.

Barney’s In Credit Penalty Box?

Credit is drying up for Barney’s. It’s on the block, but price expectations need to come down to Earth. Indirect impact on vendors is a greater consideration than a near-term hit.

Rumors are swirling in the industry that the Factors (intermediaries facilitating frictional credit between retailers and suppliers) have put Barney’s in the penalty box and stopped approving Spring orders. Unfortunately for Barney’s, this is usually a self-fulfilling prophecy in that once ‘payment issues’ are the topic du jour, it usually ends up impacting product flow and business to a greater degree.

I’m not sure if the issue here is solvency. In fact, since Istithmar (Dubai’s government-funded investment arm) bought Barney’s from JNY in 2007, it has underperformed, but remains profitable. The issue is that there is no CEO, and Istithmar is trying to sell Barney’s for a price in the vicinity of the $942mm it paid JNY in July 2007.

Guess what Istithmar… the 14x EBITDA you paid in mid-2007 before the credit crisis is a lot different from where such an asset would be priced today. You should know this -- $75 oil helped fund your mid-’07 purchase when you outbid Japan’s Fast Retailing. Not as much to bank on after a 45% slide in oil, a 2-3 point slide in margins, and weaker sales on the margin. I’d need to assume a high teens multiple no for anything close to $1bn. Sorry… no can do.

Fortunately, no vendors are overly exposed to Barney’s. Most of the companies dependent on Barney's listed in public documents (per Cap IQ) are systems and software-related. But Barney’s is an important ‘showcase’ account. For example, Timberland had a big win when it got a pair of its lux boots sold in Barney’s last year. This creates a halo effect for the brand. Saks is not exactly knocking the cover off the ball either. I don’t like seeing fewer showcase locations. If Barney’s situation gets worse, this will definitely nudge some companies into evaluating how they approach brand positioning.

An important consideration is if that Barney’s credit issues are solely because of uncertainty around its future ownership – but as a stand-alone retailer it remains a viable entity (quite possible), then this could be an opportunity for those retailers with solid balance sheets (i.e. RL) to pick up a few points of share by working with Barney’s during this period.

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